Real Estate Reckoning

The foundations of the global commercial real estate market are shifting. Since 2020, a confluence of factors – a dramatic shift in how buildings are used, the fastest surge in interest rates in more than 40 years, bank failures in the U.S. and Europe, and now a looming recession – could prompt price declines not seen since the global financial crisis 15 years ago.
This upheaval will challenge rules of thumb and require a fresh approach to real estate underwriting. Over the cyclical horizon, commercial real estate dynamics are likely to get worse before they brighten. For investors, this may seem daunting. But it also could be one of the best periods to deploy capital in decades.
There’s no doubt, however, that the pandemic has transformed rental housing, offices, retail, and other sectors, and that market trends will play out differently across countries and regions. For example, office buildings in central business districts in cities such as San Francisco are challenged by remote work trends. However, enthusiasm for working from home has been less pronounced in markets such as London, as well as Singapore and other Asian capitals, particularly for individuals going to high-end, sustainable offices in alluring locations. Likewise, there is a discrepancy in the U.S. between real estate investment trusts (REITs), which lost about a quarter of their value in 2022, and prices in private markets.
We believe these crosscurrents will create volatility and opportunities for relative value investing across the four quadrants of public and private debt, and public and private equity.
Patience also will be important, as supply and demand will ultimately determine the long-term value of real estate. Land-use restrictions and high construction costs will reduce supply more than in any previous cycle, underpinning real estate values over the long term, in our view.

Let’s look at how cyclical and secular trends may play out across key commercial real estate sectors across regions, from those enjoying tailwinds to the most stressed.
  • Residential housing will likely benefit from long-term trends such as urbanization, increasing household formations, and rising costs of home ownership. Student housing may benefit as more learners go abroad to schools in the U.S., U.K., Australia, and other countries. Supply remains below historical levels and we anticipate limited price declines and healthy rental growth.
  • With banks sidelined, we see attractive opportunities to lend to development and value-add projects. On the equity side, we see potential in newer properties in select urban gateway markets at less expensive entry points.
  • Investors may benefit from diversification into areas such as core and core-plus properties and developments near leading universities. As with other sectors, multifamily and student housing will likely benefit as investments flow from office and retail markets.
  • The hotel sector has recovered from the pandemic-induced downturn and remains resilient despite a deteriorating economic backdrop and rising operating costs. While business travel may slow, we believe tourism will continue to spur demand, including from Japanese and Chinese travelers. Sustainability concerns should also boost energy-efficient and eco-friendly operations.
  • Lodging has traditionally relied more heavily on commercial mortgage-backed securities (CMBS) and regional banks for financing. But the contraction in these sources of finance could create attractive opportunities for lenders capable of underwriting these operationally complex real estate assets.
  • In recent years, the growth of e-commerce has pushed down retail rents and valuations. As we expect recession to tamp down spending in the U.S., businesses providing nonessential products appear most vulnerable to further declines. In contrast, we don’t expect significant further correction in prices of Class A assets.
  • We believe investors should focus on multitenant properties in prime locations. These have proven resilient, and investors have been gradually returning, even though rental growth is likely to be muted. Equity investments in shopping centers anchored by grocery stores and retail properties in traditional, prime locations appear attractive in the U.S., while debt investments for assets such as these may be preferable in Europe.
  • No property sector has been hit harder than office buildings. The pandemic normalized remote working, which we expect will continue in the U.S. In Europe, by contrast, workers have generally returned to the office, particularly those going to modern offices with desirable working environments. As a result, our research suggests that clearing prices for U.S. office assets today are down by 25% to more than 40% from 2021 levels versus declines of 15% to 20% for office properties in Europe and Asia-Pacific, which have higher occupancy levels. With this backdrop, we expect to see increasing distressed sales in the U.S., versus selective and limited sales in European and Asian markets.
  • Going forward, we see a trifurcation of the office sector. Best-in-class assets – buildings with low carbon footprints, appealing amenities, alluring locations, and high occupancy – will likely weather the storm. We also see opportunity in “brown-to-green” investments that target Class B+ and A- properties, especially in prime locations in Europe and Asia-Pacific. However, we expect mid-quality structures will require upgrades in order to survive, while the lowest-quality assets will become obsolete, leaving owners facing big losses.
  • In conclusion, we’re in a challenging macroeconomic environment that requires versatility, patience, and a long-term perspective. We believe investors should lean into the target-rich opportunity set in real-estate-related credit over the near term, while remaining strategic and patient in equity. For long-term investors, we believe that equity strategies focused on assets that will benefit from secular trends – including demographics, digitalization, and decarbonization – will drive value creation.
John, M. & Francois, T. (2023 June 20). Real Estate Reckoning. Pimco website. Retrieved June 23, 2023, from